Darlene L. Wilcox

A Pragmatic Approach to the Cost-Benefit Analysis of GIS

Abstract.

Understanding the costs and benefits of starting or expanding a GIS is an important part of the strategic planning process. Determining the economics of a GIS is complex. A variety of approaches, some mandated by government or corporate standards, some invented when the need arises, and some on the ethereal edge of theory, have been used in the recent past. This paper will outline a well-designed, consistent approach to determining and valuing the costs and benefits of a GIS. Cost valuation issues focus on fair determination of staff, equipment, and other costs, particularly when comparing alternate implementation scenarios. Benefit valuation incorporates a clear division of direct, indirect, and external benefits. Finally, the costs and benefits are applied over time, with clear cost- benefit information offered for the decision making process.


Introduction.

Cost-benefit analysis (CBA) is a tool that, to the greatest degree possible, takes opinion and emotion out of decision-making. CBA offers a framework for organizing the pros and cons (the benefits and costs, respectively) of each alternative. It doesn't tell what is the right decision, but it does put the options onto as level a playing field as possible.

From a theoretical standpoint, CBA is a tool for comparing options, particularly in the public sector. Public sector decisions are thought to be more complex because both policy and financial impacts must be considered. On the other hand, private enterprises theoretically need to be concerned only with the accountant's 'bottom line'. In reality, though, both private and public sector decisions are better when they consider all aspects of a given alternative, whether those aspects have a line in the balance sheet or not.

What we face is the difference between theoretical eloquence (which has its' weaknesses anyway) and real-world practicality. The goal is to find a practical way to accomplish the task at hand -- that is, performing the CBA -- while not opposing the basic theory of cost-benefit analysis. Note that this is not the same as embracing all the eloquence of theory. With this caveat, let us go on to the practical realm of CBA, pausing first to cover some past work in this area, and briefly, some basic cost-benefit theory.

Past Contributions.

Past contributions concerning the CBA of geographic information systems (GIS) tended to focus on understanding the theory (a good example is Epstein and Duchesneau's 1984 argument for the inclusion of avoided costs as benefits), or on developing a statistically significant but practically obscure approach to CBA (see Benjamin and Fadel, 1995). Some have said that it's too difficult to put numeric values on some classes of benefits (Calkins and Dickinson, 1988), but this was rebutted in Wilcox (1990) and by Smith and Tomlinson (1992), who argue that there are few things that cannot be valued.

There have been, though, very few papers written that offer a pragmatic outline of how to undertake a cost-benefit analysis for a geographic information system. Smith and Tomlinson (1992) present a method similar to the one offered here. Indeed, this paper marks an expansion of the method outlined in that work.

Theory.

There are three key items of theory in cost- benefit analysis. To start, there is the cost:benefit ratio. Second, there is the issue of alternatives. Lastly, there is the need to find and use the net present values (NPV) of the costs and benefits.

The benefit:cost ratio is just that -- a fraction representing the return (benefit) on the investment (cost). Usually the denominator -- the cost side -- is reduced to one (1). For instance, a $10,000 investment that returns $16,000 would have benefit:cost ratio of 16,000:10,000, or more commonly, 1.6:1. Any undertaking that offers a return greater than 1:1 satisfies one major requirement of economic justification: break-even -- that is, you won't lose money on the deal. However, there is another requirement, which is related to the economic concept of opportunity cost. Simply said, when deciding between two (or more) options it is not economically justified to select the option with the lower benefit:cost ratio. That is, if you have two options, one returning 1.6:1 and the other returning 2.1:1, the 1.6:1 option is not economically justified. The foregone opportunity (the one returning 2.1:1) is worth more. (Still, it may end up that the 1.6:1 is the preferred choice, because of other institutional, intangible, or non-economic considerations.)

The last issue is the future, and the impact it has on the numbers used in the CBA. Benefits in the future are valued less than benefits now. A simple example: compare getting $100 now or $100 next year -- the $100 now is preferred. The future benefits (and costs) must be discounted. Experience shows that a discount rate of 7 percent has proven reasonable (Nas (1996) validates this). This means that the evaluation is not $100 now versus $100 next year; instead it is a comparison of $100 versus $93 now. That is, the net present value (NPV) of $100 in one year is $93.

The Cost-Benefit Framework.

The most important aspect of CBA is that the results must be looked at over time. In the first year or years the costs tend to outweigh the benefits. The up-front outlays in planning, system setup, data automation, application development, staffing, and training do not produce immediate benefits. Typically benefits begin to accrue in the second and third years, and then quickly surpass the yearly costs.

Thus, it is important to look at costs and benefits over time -- but not too long. There are too many uncertainties if the planning horizon is extended too far into the future. Hardware and software advances are expected to occur, but the impacts of those advances on the costs and benefits are just too uncertain. Experience shows that a six-year planning horizon is reasonable.

Over this six-year planning horizon there is a very typical pattern of costs and benefits. In the first years costs are high, and benefits are low. In the latter years benefits often greatly surpass costs. Thus, it is necessary to look at the cumulative effect of the costs and benefits over time. This is easily done once the cost and benefit numbers for each year are known. The cumulative numbers for the second year are the sum of the numbers for the first and second years, and so on until the sixth year, in which the numbers reflect the total costs and benefits for all six years.

In one recent project the benefit:cost ratio for the first year was 0.5:1, improving to 6.4:1 in the sixth year. Over the six years, this resulted in a cumulative benefit:cost ratio of 2.8:1.

The last manipulation of the annual benefits and costs involves discounting them over the six-year planning horizon. Because costs tend to be borne early and benefits late, and the value of future funds is less than that of current funds, the net result of discounting tends to be a downward force on the benefit:cost ratio. In the same project referred to above, the cumulative, discounted (at 7 percent) benefit:cost ratio for the six-year planning horizon was 2.6:1.

The project used here as an example shows fairly typical results. Experience has shown that a well-planned, carefully implemented GIS can achieve a long-term, fully discounted, cumulative return about 2.5:1 over the foreseeable planning horizon. This means that every dollar invested in hardware and software, data automation, system start up, application development, and the ongoing costs of operations can reap about $2.50 in benefits. Note that the 2.5:1 ratio is historic, and because every case is individual, no one can be assured of returns equal to this. In recent cases there have been returns ranging from less than 1:1 to 6.6:1. Individual projects have returned from 0:1 to nearly 20:1.

The Units to Measure.

Good strategic planning offers the client a blueprint for putting the GIS in place. The methodology developed by Tomlinson Associates focuses on the information outputs the GIS can produce. The costs of creating these outputs, and the benefits generated from these outputs are carefully measured. The cost-benefit analysis, along with data considerations and so on, gives the reasons for prioritizing certain outputs. Concentrating on each potential output, one at a time, makes it possible to clearly identify the potential benefits and costs of the GIS.

The planning effort should begin with a cataloguing of potential outputs. These outputs should be briefly described, and their potential benefits scoped out. This is an important step, which helps focus attention on those areas where GIS can offer the greatest impact. It can also avoid the problem of spending days defining and performing the CBA on an output that can ultimately generate only a trivial amount per year in benefits.

A second task to be done before individual outputs are defined is to catalogue the prices to be associated with costs and benefits. The most important thing is to define a salary scale for clerical, technical, professional, and administrative personnel. This is particularly important when working with multiple departments or agencies, because it keeps each unit's costs and savings on a comparable level.

Counting Costs.

Counting the costs of creating a particular output is relatively easy compared to counting the benefits. This is because there is a fairly well- defined list of items to consider for costs. Hardware, software, data, application development, staffing, training, and maintenance are the key items.

When the client has a system in place or a specific system in mind cost determination is straightforward. In most strategic planning this is not the case, and the costs are determined by getting estimates from the major vendors. A variety of options should be considered. For instance, hardware options should include workstations and PCs, and include network considerations. The conservative approach is to use the highest estimate unless it is significantly beyond the scale of the majority of vendors. When considering staffing issues it is important to include employee overheads (on-costs) in addition to base salary. This will more accurately represent the cost of staffing.

Counting Benefits.

There are no fixed categories of benefits. This makes counting benefits much more difficult than counting costs. Past categories that have been successfully used include primary and secondary; tangible and intangible; internal and external; and tactical and strategic. The latter, proposed by Yourdon (1989), differentiates between lower costs of producing the same outputs and producing new outputs. That can be a valuable differentiation when evaluating the risk associated with establishing the GIS.

In a large, government-wide project undertaken by Tomlinson Associates, benefits were grouped into four categories: direct, agency, government, and external. Direct benefits were those accruing as a result of using GIS rather than manual means for storing and producing information. Agency benefits reflected the increased productivity and improved quality of work credited to the better and more timely information produced by the GIS. Government benefits were similar to agency benefits, but considered how better information generated by one agency benefitted other agencies. Lastly, external benefits focussed on both qualitative and quantitative benefits that accrue outside the structure of government. A valid equivalent for the private sector would be direct, departmental, company-wide, and external.

Direct Benefits.

Examples of direct benefits include all manner of operational efficiencies. Staff savings is a prime example. Staff savings could mean a reduction in staff, or the ability to undertake additional activities without an increase in staff. In the first instance, the benefit equals the eliminated salary (with overheads (on-costs)). In the second instance the benefit is measured by the value of the new activities. In one recent instance a body of work currently consulted out could be brought in-house. The reduction in the consulting budget was recorded as a benefit. Another key example of direct benefit is the reduced purchase of products (such as maps) or services from outside providers.

Agency (Departmental) and Government (Company- wide) Benefits.

Agency and government benefits each reflect better outcomes from having better (more accurate, more complete, more timely) information from which to make decisions. There can be an improvement in efficiency, reflected in staff savings or a reduction in the usage of other resources. Faster performance can result in increased revenues, or in revenues being earned sooner, and thus generating greater interest income. Faster performance can also result in greater customer satisfaction, and thus greater sales. Reduction in fines (from avoiding errors that could be penalized) and improved position in litigious situations can result in very large benefits.

External Benefits.

External benefits accrue to outside entities, whether they be other firms, the public at large, or the environment. Often these are the most difficult to quantify. There are two reasons for this. First, it becomes difficult to determine what value the recipients place on the benefits. (Who could or should be asked?) Second, some benefits are intangible, and no good proxy exists. This is the case, for instance, when improved information can avoid the destruction of a non- renewable resource, such as an archaeological site. Every effort should be made, however, to indicate the worth of any cited benefit. For example, one archaeological society was able to identify the amount of tourism directly attributed to archaeology. Reduction in archaeology resources would impact negatively on this portion of tourism revenue. In another instance, an oil/gas company was able to credit a reduction in fines paid because they were better able to avoid damaging archaeological resources.

Conclusions.

Cost-benefit analysis is not an easy undertaking. The guidelines suggested here offer a structured approach to counting the costs and benefits associated with each potential output of the GIS. The resulting benefit:cost ratios are used along with other key information to complete a strategic plan for GIS development. A good strategic plan will indicate when purchases should be made and when each justifiable output can be undertaken. If desired, a number of strategies could be produced, for instance, to compare the long-term results of a high front-end investment versus a longer-term, more steady rate of implementation. When a clear picture of the costs and benefits of a GIS is presented it can be compared to other competing alternatives to identify the best use of resources.

Acknowledgments.

The author wishes to thank Dr. Douglas A. Smith of the Department of Economics, Carleton University, Ottawa, Ontario, Canada for helping me define the direction of this paper; Dr. Roger F. Tomlinson, President, Tomlinson Associates, for the opportunity to learn and expand upon his methodologies; and especially Dr. Duane F. Marble of the Department of Geography, The Ohio State University, Columbus, Ohio for his ongoing support and wisdom, as well as his input to this paper.

References.

Benjamin, Colin O. and Adel Fadel, 1995. "Justifying Automated Mapping Systems in Small Communities" in URISA Journal, vol. 7, no. 2, pp. 22-34.

Dickinson, Holly J. and Hugh W. Calkins, 1988. "The economic evaluation of implementing a GIS" in The International Journal of Geographical Information Systems, vol. 2, no. 4, pp. 307- 327.

Epstein, Earl F. and Thomas D. Duchesneau, 1984. The Use and Value of a Geodetic Reference System. Rockville, Maryland: National Oceanic and Atmospheric Administration, National Geodetic Information Center.

Nas, Tevfik F., 1996. Cost-benefit analysis: Theory and application. Thousand Oaks, California: Sage Publications, Inc. 220p.

Smith, Douglas A. and Roger F. Tomlinson, 1992. "Assessing costs and benefits of geographical information systems: methodological and implementation issues" in The International Journal of Geographical Information Systems, vol. 6, no. 3, pp. 247-256.

Wilcox, Darlene L., 1990. "Concerning 'The economic evaluation of implementing a GIS'" in The International Journal of Geographical Information Systems, vol. 4, no. 2, pp. 203- 210.

Yourdon, Edward, 1989. Modern Structured Analysis. Englewood Cliffs, New Jersey: Prentice-Hall, Inc. 672p.

Please contact the author for further information on the Tomlinson Associates projects referenced in this paper.


Author Information.

Darlene L. Wilcox, Senior Associate
TOMLINSON ASSOCIATES Consulting Geographers
65 Forest Grove Road, Oxford, Mississippi 38655
Telephone (601) 238 2823 / Fax (601) 281 8424
E-mail: darlene927@aol.com